What is asset protection planning?
Asset protection is when you have a plan in place to protect your wealth. It’s a form of financial planning that safeguards your assets from creditor claims, taxation, seizures, or other losses. Plus, it’s totally legal (and a good idea) for both individuals and businesses.
Illegal practices look like concealment (hiding your assets), contempt, fraudulent transfer (as defined under the 1984 Uniform Fraudulent Transfer Act), tax evasion, and/or bankruptcy fraud. In other words, all methods you want to avoid. Asset protection planning makes it easy to do so.
Asset types & associated risk
There are different types of assets, and each comes with its own varying levels of risk. Let’s break it down for you.
Assets that are considered dangerous or risky
Dangerous assets are anything that could increase the risk of a lawsuit that could end in financial loss. They’re usually physically tangible rather than not, meaning they have the potential to cause physical harm to others (i.e. something that could lead to the asset owner being sued). Examples include:
- Vehicles like cars or motorbikes
- Machinery or equipment
- Rental real estate
Assets that are considered safe
Safe assets are things that do not have a high degree of liability. They’re also generally owned by individuals and can help diversify an investment portfolio, helping you during any volatile market times. It’s not wise to commingle dangerous assets with safe assets, or even with other dangerous assets. Keeping everything separate will decrease your likelihood of losing individual assets. Some examples include:
- Treasury bills
- Individual bank accounts
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Common asset protection strategies & entities
There are a few different routes you can take to protect your individual and business assets. The best protection involves a combination of legal tools and financial planning to shield any and all of your valuables from lawsuits. This means you’ll have to compile a list of assets that need protection and then analyze which legal strategy would be the most ideal protection. Here are five different strategies to consider:
- Create a Limited Liability Company – Using an LLC is often the number one strategy. This is because they include provisions that keep creditors from taking the company or any assets they possess. In most jurisdictions, there is an exclusive remedy called a charging order. This states that the creditor has the right to distributions paid out from the LLC and they are responsible for the taxes whether they are paid or not. Which means the creditor cannot force you to make payments and they can be stuck with the tax bills instead of you.
- Use an Asset Protection Trust – This is one of the most powerful protection tools in case of a lawsuit. An offshore trust cannot be touched by local courts or the hands of your opponent’s attorney. They’re also one of the only options that work after a lawsuit is filed.
- Don’t Own Anything Yourself – Well, of course you’re going to have your own things! But we’re suggesting that you don’t hold any non-exempt assets in your own name. This will protect your most vulnerable assets if creditors sue you personally. For example, if you own rental property, hold it in a land trust for privacy of ownership. Or put your car title in a holding trust to keep your name out of public records. You’ll have access to all your assets and your opponent won’t. Plus, everything in your trust will pass on to your heirs as trust beneficiaries when you pass away.
1. Create an asset protection plan
So when do you start asset protection planning? Unfortunately, it can’t begin when a potential lawsuit is already on the horizon. This is because every state has its own laws that protect creditors from people who transfer assets out of their names with the intent to defraud, hinder, or delay payment.
Any court will see this as a “fraudulent” transfer and order that the transfer be reversed, which also means your assets will be turned over as payment to the creditor owed. That’s why it’s essential to begin asset planning as far from any sign of a lawsuit as possible. To get started, you’ll need to establish your short and long-term financial goals, as well your estate planning goals.
2. Determine your financial goals
It’s intimidating to determine your short and long-term financial goals! Especially because asset planning tends to make some people think about the big, scary “D” word – “death.” But doing so will help you learn about your current financial situation, ensure you have money to retire, and will keep your assets safe with your heirs after you pass on.
Review your current assets to decide which are exempt from creditors. You can reposition anything that isn’t to become exempt. Financial planning will also help you organize any future assets you may want to acquire and you’ll know just how to protect them from creditors.
Once your financial goals are set, you’ll know your current net worth and have an estimate of how much money you’ll earn in the future. With this, you can begin estate planning. Estate planning determines who will take care of your financial assets should you become mentally incapacitated, as well as any children or dependent family members if you die unexpectedly. It can also include asset protection planning strategies like a family limited liability company or trusts for yourself, your spouse and children, and/or other beneficiaries.
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3. Limit your liabilities through a legal entity
Legal entities are used to protect your assets. Here’s a breakdown of each type of legal entity you could use:
- Sole proprietorship – This offers zero protection for your personal assets against lawsuits that may expose your home, car, bank accounts and anything else you’ve worked hard for! You should definitely consider incorporating or forming an LLC because they separate you as the owner from the business creating a “corporate veil.”
- General partnership – This is an association of two or more people in business together. It can be either a written or oral agreement. In terms of asset protection, it doesn’t offer much. Each person would be personally liable for all debts in the partnership, including debts incurred by the other partner. And, either partner can act on behalf of the other without their consent or knowledge.
- Limited partnership – Also called an LP, these are authorized by state law and consist of one or more general partners and one or more limited partners. The same person can be a general or limited partner given there are at least two legal persons or entities in the partnership. A general partner is responsible for managing the partnership and has unlimited personal liability for any debts. The limited partner(s) have no personal liability for debts beyond what they contribute, which also gives them less control over business management.
- Family limited partnership – This arrangement is for family members to combine their money to run a business project. Every member of the family will buy a unit or share that equals a portion of the profits earned. There are also general and limited partners in this type of agreement.
- C-corporation – Registering your business this way protects your personal assets and any shareholders from court rulings, losses, and debts against your business. Its liability protection can also extend to your business’s employees and directors too.
- S-corporation – This is very similar to a C-corporation only that it qualifies for a special IRS tax election that has corporate profits pass through the business and be taxed at the shareholder level. To qualify, your business must pass certain qualifications and meet the number and type of shareholders required, as well as how profits and losses are allocated among them and the kinds of stock issued to investors.
- Limited liability company – This means you are establishing a new business entity that is legally separate from you personally. It provides great protection as creditors won’t be able to go after you as an individual if you can’t pay back your debts.
- Nonprofit – These are private organizations that operate for public purposes using ethical, open, and transparent methods. If your nonprofit owns any property, supplies, or equipment, you’ll have to have an asset protection plan in place. Even if your business is bettering the world, it’s still at risk from creditors.
4. Reduce risk with insurance
No one wants to work, save, and invest throughout their entire life only to have it all taken away in a lawsuit, divorce, or bankruptcy. And statistically speaking, we all know that unfortunately, this could happen to just about anyone who hasn’t planned to protect themselves.
Review the details of your liability insurance program with your insurance professional. They can ensure your policies are up-to-date, you have adequate coverage limits, and reasonable deductibles. Be sure to go over everything with a fine-tooth comb, searching for any possible loopholes.
5. Discuss your asset protection options with a law firm
It can be tempting to avoid legal fees to create and maintain your business as a legal entity. But why avoid something that’s only going to serve and protect you? Whether you’re a small business owner or running a Fortune 500 company, doing business through a legal entity will provide considerable risk management benefits. Plus, a law firm is going to understand all the fine print and legal jargon that may be confusing. Invest in your future by working smarter in the beginning, not harder overall!